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Exam 27: Tools of Finance

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Question 41

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Stockholders of ComfortAir Corporation, an air conditioner and furnace manufacturer, are concerned that the company's executives may take on greater risks than stockholders desire. This example illustrates

A) moral hazard and market risk.
B) moral hazard and firm-specific risk.
C) adverse selection and market risk.
D) adverse selection and firm-specific risk.

E) All of the above
F) B) and D)

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Question 42

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Historically the return on stocks has been higher than the return on bonds. In part this reflects the higher risk from holding stock.

A) True
B) False

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Question 43

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The market for insurance is one example of reducing risk by using diversification.

Scenario 27-2 ​ Suppose Dave has a utility function $U = 4 W ^ { 1 / 2 }$ where W is his wealth in millions of dollars and U is the utility he obtains. ​ -Refer to Scenario 27-2. Suppose Dave is faced with a choice between two options. With option A Dave receives a guaranteed $2 million. With option B Dave faces a lottery that pays $0 with probability 0.8 and pays $10 million with probability 0.2. Given Dave's utility function, will he prefer option A or option B? Provide evidence to support your answer.

Suppose Dave drives more recklessly when he has car insurance than when he does not have car insurance. This is an example of the moral hazard problem associated with insurance.​

If a savings account pays 7% interest, then according to the rule of 70 how long will it take for the account balance to double?

Figure 27-1 The following figure shows a utility function for Ren. -Refer to Figure 27-1. Suppose Ren begins with $1,050 in wealth. Which of the following coin-flip bets would he definitely not be willing to accept?

Adverse selection is illustrated by people who take greater risks after they purchase insurance.

Sage decides to cash in all his savings to open a recording studio. He has three accounts to cash in. The first earned 9 percent for two years. The second earned 6 percent for three years. And the last earned 3 percent for six years. Supposing he started with $5,000 in each account, from which account will he get the most cash?

Figure 27-2 The following figure shows a utility function for Alex. -Refer to Figure 27-2. From the appearance of Alex's utility function, we know that

On the Internet you find the following offers for opening an online account. Which of them is the best offer if you have $2,000 to save for two years?

Suppose that interest rates unexpectedly rise and that FineLine Corporation announces that revenues from last quarter were down but not as much as the public had anticipated they would be down. According to the efficient markets hypothesis, which of the following makes the price of FineLine Corporation Stock fall?

If a friend tells you that he is certain a stock price will rise based on information he heard on television or saw on the Internet, should you be skeptical? Explain.

The concept of present value helps explain why the quantity of loanable funds demanded decreases when the interest rate increases.

A University of Iowa basketball standout is offered a choice of contracts by the New York Liberty. The first one gives her $100,000 one year from today and $100,000 two years from today. The second one gives her $132,000 one year from today and $66,000 two years from today. As her agent, you must compute the present value of each contract. Which of the following interest rates is the lowest one at which the present value of the second contract exceeds that of the first?

In the 15 years ending February 2016, most active portfolio managers failed to beat the market.

Suppose you win a small lottery and you are given the following choice: You can receive (1) an immediate payment of $5,000 or (2) two annual payments, each in the amount of $2,700, with the first payment coming one year from now, and the second payment coming two years from now. You would choose to take the two annual payments if the interest rate is

What is meant by an asset bubble?

Scenario 27-2 ​ Suppose Dave has a utility function $U = 4 W ^ { 1 / 2 }$ where W is his wealth in millions of dollars and U is the utility he obtains. ​ -Refer to Scenario 27-2. Suppose Dave is faced with a choice between two options. With option A Dave receives a guaranteed $2 million. With option B Dave faces a lottery that pays $10 million with probability P and pays $0 with probability (1-P). Given Dave's utility function, how high does P need to be before he will prefer option B over option A?

Your boss asks you to do fundamental analysis of a corporation. What value is she asking for and how would you estimate this value?